"Early-am" falls through the cracks

The recent tripping of an early amortization trigger ("early-am") for NationsBank CLO Commercial Loan Master Trust had some investors questioning why they were not made aware of the situation prior to purchasing the notes, sources said.

The deal, NBCLT 1997-2, was a landmark securitization when it priced. According to market sources, the collateral, described as "sterling," had seen little deterioration of credit but failed diversity-score requirements unique to the transaction. This, in turn, triggered a payout six months earlier than expected.

While most market participants reacted to this news with little more than a sigh, the floating-rate nature of the deal caused the paper to trade close to par in the secondary market, sources said. Some investors who focus on bonds with short maturities - securities lenders, for example - had purchased this paper at a premium from long-term investors who were seeking to take profits and add duration in recent months.

Due to the increasingly stringent restrictions placed on banks' lending practices over the years since origination of the deal, the diversity of the loans in the CLO, as well as the size of the revolving pool, has steadily decreased in recent months. The diversity of CLO portfolios is usually measured by a formula that quantifies exposure to various sectors or industries.

For example, JPMorgan's CDO handbook states: "Ten credits in 10 industries have a Moody's diversity score of ten while ten credits in the same industry have a diversity score of four."

Upon discovering the trigger had been breached, the servicer, Bank of America, sent a letter on Feb. 14 to the trustee, Bank of New York as well as the three rating agencies. Bank of New York refused to comment on this issue.

"The Early Amortization Event results from not meeting a Moody's test as of the last day of two consecutive monthly periods. The Moody's test that resulted in the Early Amortization Event was the Moody's Diversity Score of all Participations, which was required to be equal to or greater than 60," the letter states. "The Moody's Diversity Scores in January and February 2002 were 59 and 56, respectively."

In the case of just about all of the recent "early-am's" being triggered, a press release quickly followed the discovery. But because the bonds were so close to maturity and the action did not affect the ratings of the deal, there was no announcement made for the next 14 days. Bank of America responded to investor concerns regarding the action by issuing a media advisory last Wednesday to dispel investor confusion.

According to the governing documents, the onus to inform noteholders falls not on Bank of America but instead on Bank of New York, as trustee. "The Trustee shall forward to each 1997-2 bondholder and the rating agencies" in the event of an early-am event, the documentation says.

While sources at both Moody's and Standard & Poors confirm the agencies were notified, the question remains as to why trades of NBCLMT 1997-2 were seen by some as late a Feb 26.

A source at Bank of America who had worked on this deal notes that this event should not have been surprising to the market, simply because the diversity score of the deal, as well as the pool balance, had been trending downward for months.

Most buysiders, however, indicated that with all the scrutiny placed on collateral performance, it is understandable that the investment community missed the checked "Yes" box under the diversity-triggered amortization question on the trustee report.

As one east-coast fund manager put it, "When you find one of these deals that works, you don't want it to go away." With all of the investor-reporting issues facing the ABS markets right now, "this just slipped through the cracks," the buysider added.

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